The Next Japan
Those attempting to see the positive in yesterday's German elections are, sadly, self-deluded. Schroeder did come back from a huge deficit; he did use anti-American rhetoric in the process, and it was apparently very effective. The CDU cannot form a majority government unless it gains the support of two or more small parties, but the Greens and PDS are both to the left of the SPD, and are hardly going to support free-market reforms.
The immediate prognosis for Germany is paralysis of the higher functions of government; its limbic system will continue running the state, but no significant reforms will be considered. This makes it certain that the nation will slide several more years down its disastrous demographic slope before acting.
The Euro bond market has rallied sharply this morning, in anticipation of a future of low growth and correspondingly low rates. Proprietary traders who shorted bonds in anticipation of a Merkel victory are suffering: ironically, their actions also created a veneer of positive economic indicators which may have aided the incumbent government.
[Update 31 October: A Wall Street Journal editorial on Paul Kirchhof, Mrs. Merkel's economic advisor, has much more on anti-American rhetoric:
Mr. Schröder left it to his minions to spell out where all these scary ideas would lead. "Kirchhof is the German representative of the American neocons who surround Cheney and Wolfowitz who are also responsible for the Iraq-war," the Social Democrats' parliamentary deputy head Michael Müller said. Mr. Kirchhof hadn't uttered a word about Iraq; but in order to demonize someone in Germany, one has to make him American. These were cheap but effective distractions from the real issue Mr. Kirchhof talked about -- the economy.Hat tip: David's Medienkritik.]